Pound Sterling to Dollar (GBP/USD) Exchange Rate Strengthens After Leaks of Deal by Next Monday

UPDATE: The Pound Sterling to US Dollar (GBP/USD) exchange rate is trading on the upside near 1.3170 area on Wednesday morning.

According to diplomats familiar with the matter, both economies have narrowed the gap on the Irish border issue, but some differences remain.

An agreement on the future trade relationship could also be achieved by November, while the divorce terms out as soon as next Monday.

UK's Brexit Minister Raab said that the UK government is still preparing for a possible no-deal Brexit, although he added that the prognosis for reaching a deal is good.

He repeated May's words that they won't accept anything that threatens the constitutional integrity of UK.

The UK will release this Wednesday Industrial and Manufacturing Production data for August, and the GDP estimate and trade balance for the same month.

Analysts at Scotiabank however warn of potential losses ahead in their GBP/USD outlook:

"Sterling may be peaking against the USD in the short run at least. Daily patterns suggest that the pound’s minor gains through late last week have topped out in the low 1.31s. A low close on the day – around current levels – would form the third leg of a “morning star” bear reversal that has developed around the 100-day MA (1.3104). We see support at 1.2970 as vulnerable. "

While the IMF also revised its US gross domestic product forecast lower this was not enough to prevent the Pound losing further ground against the bullish US Dollar.

Investors were not impressed by the accompanying suggestion that the Bank of England (BoE) take a more cautious approach to monetary policy, raising the prospect of an interest rate cut in the event of a hard Brexit.

The IMF report stated:

‘In the United Kingdom, where the output gap is closed and unemployment is low, a modest tightening of monetary policy may be warranted, although at a time of heightened uncertainty, monetary policy should remain flexible in response to changing conditions associated with the Brexit negotiations.’

This left the Pound vulnerable to a fresh bout of selling pressure as confidence in the outlook of the UK economy weakened once again.

A weaker-than-expected NFIB small business optimism index diminished the appeal of the US Dollar, however.

Following on the heels of the IMF’s downgrade US economic forecast this easing in business confidence undermined the strength of USD exchange rates.

Investors were further discouraged by the latest commentary from Dallas Fed President Robert Kaplan, who sounded a more cautious note on monetary policy.

As Kaplan indicated a preference for the Federal Reserve to pursue patient and gradual interest rate hikes until at least June 2019 the US Dollar came under pressure.

This more dovish commentary diminished bets on the prospect of the Fed raising interest rates again imminently, although markets continue to see high odds of a November or December hike.

If other Fed policymakers adopt a similar tone in the days ahead this could weigh heavily on USD exchange rates.

Signs of easing in September’s US consumer price index data may also put pressure on the US Dollar, even though this is not the Fed’s preferred measure of inflation.

A dip in the headline annual CPI would give the Fed greater incentive to leave interest rates on hold in the near term.

On the other hand, as long as price pressures continue to run above the Fed’s target level USD exchange rates are likely to remain on a stronger footing.

Pound Exchange Rates Vulnerable to Weaker Monthly UK GDP

Market anxiety over Brexit could keep Pound Sterling under pressure for the foreseeable future, as the UK and EU have still yet to resolve key issues.

As analysts at Rabobank noted:

‘Negotiations between the EU and the UK are expected to intensify ahead of the EU top on 18-19 October. Lack of progress on the Irish conundrum by then could derail talks and thereby increase the odds of a ‘hard Brexit’.

‘Meanwhile we maintain our base case that the EU and the UK will reach a last minute deal that stipulated a transition period and a Free Trade Agreement after that. Nevertheless, the risks of a hard Brexit remain uncomfortably high.’

Further weakness could be in store for GBP exchange rates on Wednesday as forecasts point towards a slowdown in August’s monthly gross domestic product reading.

If UK GDP eases from 0.3% to 0.1% in August this would leave the Pound vulnerable to fresh losses, with the risks of a weaker third quarter GDP result rising.

A widening of August’s visible trade deficit could also put pressure on the GBP/USD exchange rate, highlighting the UK economy’s vulnerability to any further deterioration in trade conditions.

Unless the economy demonstrates greater signs of resilience the mood towards the Pound is likely to sour further, especially if corresponding production data also shows signs of weakness.

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Colin Lawrence

As well as producing in-depth analysis of the latest currency trends for ERUK, Colin heads up the Business...